Restricting Tax Bodies Interference Into Company Activities


In 2008, the court practice related to tax disputes was marked by a number of important decrees adopted by SAC of the RF that may lead to some reduction of tax control, as well as to the limitation of some issues of the entrepreneurial activity to which it may relate. The issue mainly includes the court decrees related to recognition of expenses as economically unfeasible, as well as court decrees concerning refusal to accept VAT for deduction by reasons not provided in the article 21 of the Russian Tax Code (onerous transaction, lack of business purpose, payment of services due to loans).

The most prominent decrees include the Decree of Russian SAC of March 18, 2008 No. 14616/07 and Decree of Russian SAC of September 02, 2008 No. 5002/08. These judicial acts deserve the attention of the business community, as they are able to correct the practice of regional courts in a serious way, as well as helping the companies to protect themselves from the unreasonable tax claims.

Within the case that the Russian SAC considered in March 2008, the tax body refused to recognize expenses for the purposes of income tax. The entity carried these costs in order to purchase legal services, rendered by independent companies. The inspectors referred to the fact that the expenses for engagement of independent lawyers were not economically feasible and thus, they were the reason for additional accrual of taxes. This conclusion was conditioned by the existence of the company's own lawyers within its staff, who executed the same functions as the engaged lawyers. In addition, the tax body considered that the prices of engaged lawyers did not comply with the level of prices that existed in the region that also shows economic unfeasibility of expenses.

Recognizing the taxpayer's position as legal, the court formulated the important principles that will facilitate decrease of unreasonable tax control by the tax body and interference into entrepreneurial activity of the companies.

First of all, the court indicated that the tax bodies' right to examine economic feasibility of expenses does not mean that the inspectors can assess the economic feasibility of businessmen's expenses, their performance and results. Under such principle as freedom of economic activity, the taxpayer conducts business activity independently, at his own risk, and has a right to evaluate its efficiency and economic feasibility independently and at his own discretion. In such a way, the court recognized that neither tax, nor court control is qualified to check the economic feasibility of decisions made by the companies that are completely independent in the field of business.

Economic feasibility of expenses that the tax body can examine means only bearing of expenses within entrepreneurial activity and their directivity to gaining of income. This refers only to intentions and purposes to gain profit, but not to the result. Such a situation is conditioned by the fact that the entrepreneurial activity has a risky nature, and tax legislation is not qualified for punishment of entrepreneurs for the business errors made when conducting business activity.

In this connection the court recognized that solution of issue related to feasibility of engagement of independent law companies when the company has its own lawyers is related to the sole company's competence. The tax body can only check the fact that the legal services are rendered in the field of entrepreneurial activity of the taxpayer.

Such approach of courts means that in the nearest time the tax bodies will not be able to dispute purchase of certain goods (for example, expensive cars), services (for instance, related to company management) as unfeasible and claim such expenses as unreasonable.

Secondly, the court recognized that the tax body cannot consider expenses as economically unfeasible based on the fact that according to the tax body the prices for services are overstated or the transaction is one-sided. The logic of the court is that article 252 of the Russian Tax Code cannot replace article 40 of the Russian Tax Code setting the reasons for control over prices. I.e. costs cannot be excluded from the structure of expenses due to such reasons as that according to inspectors the prices for goods, works, or services are overstated. If the tax body doubts the correctness of price, it shall turn to article 40 of the Russian Tax Code. However, the given provision sets the exhaustive list of reasons for control over prices, namely: between the interdependent parties; within product exchange (barter) transactions; in the conduct of foreign economic transactions; at deviation from the level of prices used by the taxpayer in relation to similar (homogeneous) goods (works, services) within a short time period by over 20 per cent. If there are not such reasons, then it is not allowed to check prices of such transactions. However, if such reasons are established, the tax body is obliged to find market prices and check if they deviate from the taxpayer's prices by over 20%. If such a deviation is revealed, the taxpayer can only leave the sum of costs complying with the market level in the structure of costs.

It is not possible to exclude all expenses due to the fact that they are not economically feasible.

This approach by the courts means that in the nearest future the tax body may refuse an exclusion of expenses from the tax base based on inspectors' opinion concerning unreasonable volume of expenses.

Within the second case to which the business community shall pay attention to (decree of Russian SAC of September 02, 2008 No. 5002/08), the court recognized that the right for VAT deduction can not depend on circumstances not provided by article 21 of the Russian Tax Code, including such circumstances as economic feasibility of expenses and one-sided transaction. It should be noted that in this case such an important issue as an opportunity to refuse in VAT deduction if services are purchased due to credit that can be repaid with new credits was also considered impliedly. Actually, the SAC recognized that FAC of Moscow region illegally obliged the court in the first instance to find out what the sum of an existing loan was and what was the planned income of the company, if such income were to be sufficient for repayment of the loan considering the company's own funds. Under article 21 of the Russian Tax Code this circumstance is of no legal importance for the acceptance of VAT for deduction. Repayment of credit that was received earlier due to the engagement of new credit does not prove gaining of unreasonable preferential tax terms. If the tax body refers to such circumstance, it shall prove it. I.e. the fact of refinancing by its own cannot be the reason for refusal in VAT deduction.

Law enforcement officials also consider the given judicial act as a positive one, as it may become the impetus for refusal from inclusion of transactions related to purchase of property due to credits into list of suspicious transactions by courts and tax bodies. Such an approach to the indicated transactions is quite popular in Moscow region. The practice should unambiguously recognize that if the company exists mainly due to borrowed funds, this is not the reason to limit its rights in the field of taxation, to consider its transaction as doubtful and the expenses as unfeasible.